Foreign investors might be the key to forecasting a U.S. recession

Japanese prime minister Shinzo Abe (L) and U.S. President Donald Trump. Japanese investors have been a major buyer of U.S. assets over the last couple years as overall foreign investment in the U.S. has risen as a percentage of GDP. Nicholas Kamm | AFP | Getty Images

The key to seeing a U.S. recession before it happens might hinge on what investors in the rest of the world are doing in America.

In a new note to clients out Monday, Carl Weinberg, chief economist at High Frequency Economics, writes that he stumbled onto a relationship between foreign direct investment (FDI) and U.S. recessions that bears watching given current trends.

Foreign direct investment, which is exactly what it sounds like — foreign investors buying real estate, financial assets and businesses in the U.S. — has risen as a percent of GDP ahead of each of the recessions since the 1980s.

And in recent years, FDI has spiked, hitting $457 billion in 2016 and $465 billion in 2015 after both 2013 and 2014 saw FDI total $201 billion.

Foreign investment in the U.S. has risen in recent years, as it has ahead of each of the last four recessions. (Source: High Frequency Economics)

“We admit to having no economic theory to explain this,” Weinberg writes. “That does not deny the correlation. We wonder if we should be concerned about the jump in FDI in the United States in 2015 and 2016 to near-record highs, since all previous spikes in FDI have been followed by a downturn.”

There are few ideas that Weinberg posits as to why this relationship might hold.

One is that foreign investments take longer to materialize than those made at home. This means that investors outside the U.S. might not eye up investments until the business cycle has started to mature, and won’t execute those deals until things are just about to turn.

Another idea, which Weinberg calls “of a more sinister nature,” is that foreign direct investment is part of an influx of speculative money that enters the economy as things heat up, thus exacerbating the impacts of a cycle’s turn.

“How much money from abroad, for instance, piled into the U.S. real estate bubble of 2007, or bought into the dotcom bubble?” Weinberg writes. “In this way, [foreign direct investment] can add incremental destabilization to a cycle in any economy.”

Look at Softbank’s recent investment in beleaguered ride-hailing startup Uber — in which the Japanese conglomerate could take up to a 14% stake in the company — and you might see signs that foreign investors are snapping up assets that may have already exhausted its U.S. investor base. Alternatively, with over $11 billion raised and 85 investors, Uber is just fine.

The recent increase in FDI might also be explained by a more benign source of motivation among foreign investors, which is that as the dollar appreciated against other currencies, U.S.-based assets became relatively more attractive.

Through the first half of 2017, FDI has totaled $155 billion, notably below the pace of the last two years, as the dollar has had one of its worst years in decades. The uptick in FDI seen ahead of the housing crisis, in contrast to 2015 and ’16, came as the U.S. dollar was actually depreciating against other currencies.

And, of course, that a relationship has held in the past need not mean that it holds in the future. The recent flattening of the yield curve, political uncertainty in the U.S., and the lack of volatility in markets have all been cited as reasons for investors to be nervous about the current economic cycle. Last Thursday’s mini sell-off and the reaction that ensued also shows that, to some extent, investors are in search of things to be worried about; perhaps FDI can take up that mantle.

But with most assessments of the U.S. economy expecting continued expansion, it is worth asking if investors from outside the country are telling us something we can’t yet see about our economic cycle.

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Myles Udland is a writer at Yahoo Finance. Follow him on Twitter @MylesUdland